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Tags: earnings | outlook | recession | profit

Going Rogue on 2017 Earnings Outlook: Profits Recession Is Over

Going Rogue on 2017 Earnings Outlook: Profits Recession Is Over

(Dollar Photo Club)

Dr. Edward Yardeni By Tuesday, 03 January 2017 11:38 AM Current | Bio | Archive

Joe and I went rogue on August 22 when we declared that the earnings recession was over.

We extended our roguery on December 13 when we raised our 2017 S&P 500 earnings estimate from $129 per share to $142, increasing the predicted earnings growth rate from 8.9% to 19.8%.

We did so to reflect our expectations that the incoming White House administration led by President-elect Donald Trump will succeed in lowering the statutory corporate tax rate from 35% to 15%.

The most frequent pushback we’ve received on this forecast is that the corporate tax cut will be a part of a much bigger package of tax reforms that won’t be thrashed out until this summer, at the earliest.

That’s true, but we are assuming that it will be retroactive to the start of this year. Since Election Day, the stock market seems to be discounting the same outlook. Even if we won’t know for sure until the middle of this year whether the tax cuts start at the beginning of 2017 or 2018, by then the market will be increasingly discounting 2018. In other words, it doesn’t matter much for the stock market whether the tax cuts are retroactive. All that matters is that they happen within the next 12 months and that they are as significant as currently planned by the incoming administration.

Now consider the following relevant observations:

(1) Industry analysts starting to go rogue too? Using our weekly “Earnings Squiggles,” Joe and I monitor the consensus earnings expectations of the industry analysts who cover the S&P 500 companies. The estimates for 2016 and 2017 have been falling since we started tracking them during September 2014 and September 2015 (Fig. 1). They both had noticeable downward trends since then, which is a very typical pattern since analysts have a tendency to be overly optimistic and are forced to become more realistic as actual earnings results approach.

The consensus estimate for 2017 is down to $132.67, implying a growth rate of 12.4% over 2016. Analysts clearly haven’t started raising their estimates to reflect a possible corporate tax cut this year. They won’t do so until company managements provide them with guidance on this matter, which won’t happen until the tax reform package is actually legislated. Only then can companies assess what their effective tax rates will be, which will depend not only on the new lower statutory rate but also on which, if any, deductions and exemptions will be eliminated as a quid pro quo for the lower rate.

We started tracking the 2018 Earnings Squiggle for the S&P 500 during September of last year. So far, the estimate has been holding up around $148. If it remains stable at this lofty level in coming weeks, that might suggest that while industry analysts won’t raise their estimates for 2017 without company guidance, they might be willing to signal their expectations that tax reform will be bullish for earnings in the not-too-distant future by sticking with their current estimate for 2018.

(2) Industry analysts upbeat on S&P 500 revenues. We also keep track of Revenues Squiggles. For the S&P 500, they show that revenues expectations for 2016 and 2017 stopped falling and have been stable since the start of the year (Fig. 2). That corresponds with the rebound in the price of oil at the start of the year, which stopped the Energy sector from weighing on overall S&P 500 revenues. Industry analysts currently project that S&P 500 revenues will grow 5.8% in 2017 and 4.7% in 2018. Joe and I think that these optimistic growth rates are possible.

(3) Forward revenues and earnings confirm Energy-led recession is over. S&P 500 forward revenues--which is a time-weighted average of the current-year and coming-year estimates--bottomed at the beginning of this year. It has been rising into record-high territory since the week of October 6 (Fig. 3). This is a good omen for actual quarterly revenues. The same can be said for forward earnings, which also has been rising into record territory since the week of October 6 (Fig. 4). All these developments confirm our view that the Energy-led earnings recession is over and that the outlook for earnings has turned brighter again.

By the way, it is interesting to note that forward earnings has been rising faster than forward revenues since the start of the year (Fig. 5). We divide the former by the latter to calculate an implied forward profit margin, which has been rising since the start of the year (Fig. 6). Again, this augurs well for the actual profit margin.

(4) The end of energy industry’s rolling recession. In late 1985 through early 1986, the price of a barrel of West Texas crude oil plunged by 67% (Fig. 7). That caused a severe recession in the oil patch, particularly in Texas. There were widespread concerns that it would spill over into the rest of the economy. Debbie and I didn’t think so and dubbed it a “rolling recession,” which rolled through just one important industry. The recession didn’t spread beyond the oil patch.

The price of a barrel of West Texas oil plunged 76% from the summer of 2014 through early 2016. Again, there were widespread concerns about an economy-wide recession that might be exacerbated by a financial crisis. Credit spreads widened dramatically: The gap between the yields on high-yield corporate and the 10-year Treasury bond jumped from a 2014 low of 253bps during June to peak at 844bps on February 11, 2016 (Fig. 8). Once again, Debbie and I believed it was another recession rolling just through the oil patch. Sure enough, real GDP continues to rise to record highs, and the credit spread was as low as 362bps early last week, which was the lowest since October 6, 2014.

Interestingly, while the US oil rig count plunged along with the price of oil, US oil field production fell just 12% from its most recent peak to trough, and has recovered in recent weeks back to 8.8mbd, 9% below its most recent peak (Fig. 9). The message from US frackers to the Saudis and Russians seems to be: “Thanks for cutting your production so that we can continue to produce lots of oil!” At the end of last year, the US petroleum industry’s inventory-to-sales ratio remained at the highest reading since 1990 (Fig. 10).

(5) Trump boosts consumers’ already upbeat expectations. While President-elect Trump remains highly controversial, there’s no debating that his policy proposals are boosting consumer optimism. Debbie and I average the monthly Consumer Sentiment Index and the Consumer Confidence Index to derive our Consumer Optimism Index (COI) (Fig. 11). Our index jumped from 94.0 during October to 106.0 during December, the best reading since December 2000. Over this two-month period, the COI expectations component is up a whopping 16.1 points to 97.5, the highest since July 2004, while its current conditions component is up 5.9 points to 119.0, at its highest readings since July 2007.

Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.

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It doesn’t matter much for the stock market whether the tax cuts are retroactive. All that matters is that they happen within the next 12 months and that they are as significant as currently planned by the incoming administration.
earnings, outlook, recession, profit
Tuesday, 03 January 2017 11:38 AM
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